In the last year alone, the positive indicators for the Philippines economy have been extraordinary; Moody’s raised its outlook to positive once the nation’s top judge was removed for corruption and Standard & Poor’s followed by boosting the foreign currencydenominated debt rating to the highest level since 2003. Overall, the $225 billion economy grew 6.4 percent in the first quarter, the fastest expansion since 2010, and the peso is now officially considered the best performer against the U.S. dollar among Asia’s most traded currencies this year.
Often overshadowed by Southeast Asian media darlings, Indonesia and Vietnam, the Philippines is finally having its moment in the sun. “I’ve had more inquiries this year about the Philippines than I have had at any other time in the last five years,” says Ben Smith, partner at Fulbright & Jaworski, a sentiment that was echoed by several sources.
Underpinning much of this positive development is President Benigno Aquino’s firm steering of the economy through several initiatives to improve governance and transparency. From announcing the selling of stakes in several gold, copper and nickel mines to attempting to reconcile local and national mining policies to jumpstarting a flagging renewables sector through feed-in tariffs, the administration has made investment into the energy industry a priority.
Although several of the announced developments have left investors and lawyers in a wait-and-see mode for now, overall, the general consensus is positive. Patricia Tan Openshaw, a Hong Kong-based partner at Paul Hastings attests that: “This government is actively taking steps to promote investment, not just by domestic, but also by foreign investors.”
A LIQUID SOLUTION
Law firms, both international and local, have seen a flurry of activity in the energy and project development sectors with several headline deals, including domestic corporation First Gen’s 40 percent buyout of British Gas’ stakes in natural gas facilities as well as Total’s recent purchase of an offshore oil and gas bloc from Mitra Energy.
Fundamental to this increase in work, especially for local firms, is the growing liquidity, strength and sophistication of the domestic commercial banks. Similar to trends noted in Thailand and Malaysia, domestic banks are increasingly well capitalised - thanks to a steady flow of $1.6 billion in monthly remittances from outside the country - well positioned, and extremely competitive, leading on many of the issuances that would traditionally have been handled by international and consortium banks.
“If a deal is relatively straightforward, and if the banks financing it are composed entirely of domestic institutions, they may be most comfortable choosing Filipino law to govern the documentation,” says Joseph Bevash, partner at Latham & Watkins, “and in that case they may not actually need international
counsel. The more complicated the deal is, the larger the deal is and if it involves multi-source financing, then of course we get in there.”
Openshaw agrees, saying: “In terms of the financing, because Philippine banks are very liquid, they have been able to fill the gap left by the foreign banks in financing energy projects.” What this translates to, in terms of legal work, is that deals that are primarily local bank-financed, tend to have local law firms on board, growing their workload significantly. As a result, sources of funding for these energy projects are growing, when previously local banks were not seen as a viable option in the market.
‘STEP ON THE GAS’ (AND OIL)
Across Asia, demand for liquefied natural gas (LNG) has never been higher. As Japan quickly shifts away from nuclear power generation, replacing its nuclear generation capacity with gas-fired generation capacity, it has become the biggest worldwide consumer of LNG, followed by Korea. Both nations are hungrily looking to invest and secure long-term purchases of LNG, rendering the market hotly competitive. Firms have seen a steady stream of oil and gas work, with massive current developments including the Malampaya natural gas project, estimated to hold over 2.7 trillion cubic feet of gas, which involves Shell, Chevron and national corporations.
The biggest headlines, however, deal with the Philippines and China’s feud over contested offshore areas, which may turn out to be Asia’s biggest military flashpoint as both countries race to tap lucrative underwater reserves. What does this mean for the marketplace? When it comes to the areas in dispute, lawyers report that understandably, investors have stayed away. The government has recently auctioned off blocs in the contested areas, but international oil and gas majors have refrained from purchasing, with the tenders going to domestic companies.
However, the Philippines is rich in offshore LNG and oil reserves, and waters that are comfortably within its sovereign boundaries continue to attract investor interest. Smith details, saying: “The companies
involved in upstream projects tend to be the smaller independents that have few producing assets. So as a result, they are going for the lower hanging fruit; the fields that they have identified from seismic
in the shallow water and the cheaper fields to exploit. And typically, the fields that one is likely to get into trouble with regarding boundary disputes tend to be in deeper water. It’s not an issue that has come to a head yet because people are staying close to the Philippine coast.”
Hector de Leon, partner at SyCipLaw, agrees, saying: “We have not really seen a drop off in work in respect to that sector. There are many service contacts with the government over areas that are not disputed; while there might be concerns over areas that are being contested, there is continued and active interest over other areas.”
Openshaw agrees, revealing that: “The nature of the business is such that the big oil and gas companies do a lot of legal work in-house, especially in the preliminary stages of exploration and development.” Once that work is completed, lawyers note that they continue to receive a healthy amount of inquiries from clients that are interested in the offshore market.
However, the competitiveness of the global market means that the Philippines could potentially be placed quite low on investors’ lists of favourable destinations, given that any quick development is unlikely. Gas fields, in particular, are long-term developments that are aimed at managing risk. So any additional new risk, especially that of political or military nature, could see investors rushing to develop other reserves first. Bevash confirms that: “The more straightforward conventional gas production resources in Western Australia are being accelerated very quickly to be developed and satisfy some of this Japanese and Korean demand. Similarly, non-traditional gas resources in America are also being rushed to market because they are based in stable jurisdictions and the price is very favourable.”
Dennis Quintero, partner at Quisumbing Torres, a member firm of Baker & McKenzie, further highlights the risk associated with offshore work: “If it will be a deep sea exploration, it’s going to be more costly for the contractor. It affects the attractiveness of the Philippines as far as oil and gas exploration is concerned.”
DIGGING DEEP
Not one to be left out of the worldwide mining boom, the Philippines has also taken steps to boost investment and stabilise the sector, reportedly worth up to $840 billion. Aquino recently announced that the government will sell stakes in gold, copper and nickel mines, in an attempt to push foreign investment. On his part, Bevash reports that: “To the extent that the government is willing to privatise some or all of its assets in strategic minerals, I would expect there to be quite a lot of interest internationally by equity participants and lenders in investing in these mining assets.”De Leon points out, however, that at the moment, there isn’t much clarity as to “which mines these even are, and as to what their respective valuations are.”
Eclipsing this announcement, however, was the ongoing moratorium that the government has announced on mining projects. Mining firms want the Philippines to lift the 18-month moratorium on new projects. However, lawmakers need to first approve new legislation on mineral revenues. “The Philippines administration has been questioning whether the country is achieving a sufficient level of return from the exploitation of its national assets in the mining and metals space,” says Mark Plenderleith, partner at Freshfields, “for the industry to move forward, financial investors will need clarity as to the form and level of return it expects as a stakeholder in the industry at both the national and local level.” The administration’s announcement is an opportune one as worldwide; nations with mining wealth are already in the process of revaluating their stakes in national assets, with Mongolia, Argentina and Indonesia being several recent examples. Sources point out that historically, mining-rich nations have wanted to attract investment and kept taxes and royalties off these mineral assets low. However, once they emerge as lucrative investment destinations for international players, many governments decide to re-evaluate their national stake in these mines.
Peter Pacheco, partner at Romulo Mabanta Buenaventura Sayoc & de los Angeles, agrees, further detailing that: “The government has issued a new mining circular which essentially stops all production activities, and only allows for exploration work to continue. The objective is for it to get a bigger share of mining revenues, because at the moment, for a concession, it is entitled to only 2 percent excise tax on gross. The government feels that is on the low side when compared to other jurisdictions that receive more from mining concessions.”
In fact, under the 1995 mining law, besides the 2 percent excise tax, foreign companies typically pay no income or export tax. Taxes are determined by self-reported production figures, another reason why there is public sentiment to reconsider the current mining regulations.
What effect would this have on projects, both ongoing and new? It is likely that while Congress reconsiders the national stake, mining permits will stall, pausing up to $12 billion in new investments planned over the next five years. Those include Southeast Asia’s biggest undeveloped copper-gold mine, the $5.9 billion Tampakan project by global miner Xstrata Plc and Australia’s Indophil Resources NL in the south of the country.
Pacheco details that: “For existing projects, the government always respects contracts, as far as investors’ rights so there won’t be any mandatory renegotiations. But of course, there can be voluntary ones. But for new ones, that’s where the government is hoping to increase its share.” Market sentiment agrees that major mining players would be open to renegotiations in the government’s stake but that resistance would be most likely found amongst the smaller to medium-sized mining corporations.
However, lawyers generally agree with Plenderleith, who says: “It raises a question in international investors’mind, particularly the international finance community, when the government says they want to have an open debate on this. Investors wonder if the debate will spread, now or during the lifetime of their proposed investments, to other aspects of the Philippine energy and natural resource sectors.”
At the time of print, the mining regulations had not been announced, leaving de Leon saying: “Right now, there is no clarity as to what will be the fiscal regime applicable to mining contracts. Investors will likely adopt a wait-and-see attitude. On the other hand, there will also be those investors who will have a bigger appetite for risk, and who will probably continue looking for mining project investments.”
A more local, but equally as significant, fracas is that of open-pit mining, which is being waged on a regional versus national level. At the centre of the dispute is the $5.9 billion copper-gold mine, the Tampakan project, located in Mindanao, which is potentially the biggest mining project in the Philippines and the fifth-largest worldwide. It is estimated to have 15 million tonnes of copper and almost 18 million
ounces of gold.
Sources report that at the local level, open-pit mining has been blocked by a provincial ban, one of the project’s major obstacles. The national government is now at loggerheads with the provincial government to reassess this decision. Recently, Swiss mining giant Xstratra, the operator of the mine, has announced that the start of production will be pushed back by two years to 2018, after its application for an environmental permit was rejected. Essentially, the problem arises from the fact that part of the project lies in the South Cotabato province, where a provincial regulation prohibiting openpit mining conflicts with a national regulation that allows it. Market sources indicate that investors are waiting eagerly to see how this battle between the local and national governments will be resolved, as it will be a key indicator for future projects.
The current state of play is that, overall, the government’s announcements to move the mining industry forward and promote investment are offset by these two issues - the reconsideration of its national return on these assets, as well as the local versus national issue of regulations. Openshaw sums up the situation by saying: “ [On large scale energy and PPP projects], the government needs to take more concrete steps to give the private sector investors comfort on the regulatory and political risks - including more clarity on the rules and the implementation process as well as providing assurance that the laws will not change midstream.”
The internal security situation is another decisive consideration when it comes to the expansion of the mining sector in the Philippines, and one that investors are watching intently. Reuters reports that around 200 Maoist guerrillas attacked three private mining projects on the southern island of Mindanao, destroying equipment worth around $70 million, and threatening more attacks earlier this year. The government is currently in talks with these rebel groups, but progress is slow. The Philippine army has said it lacks the resources, and so has asked mining firms to hire private militias to guard their businesses. Sources interviewed say that this is a significant developing story that many are keeping a close eye on.
Taking a big picture view, there is one final factor that affects the market, and that is the slowdown in China. As its need for resources grows sluggishly, the urgency in developing and expanding existing reserves also dims. Interviewees’ note that before the race to explore, mine and finish facilities was fuelled by China’s seemingly unending appetite, but now the situation is not as frantic. Investors have time to consider their projects more selectively, manage their expectations, and assess the market.
Given all this, Pacheco finds that: “We are in a wait and see pattern for new investors, while for the existing ones, it is business in usual.” Only time will tell how this will play out. However, the general consensus in the marketplace is positive and optimistic that the right steps are being taken to ensure a consistent stream of investment and development in the mining sector.
HERE COMES THE SUN
Critical breaking news in this industry are the recent feed-in tariffs announced by the Philippine Energy Regulatory Commission (ERC) for renewable energy. After a protracted process, first started in 2008 and plagued by government indecision and opposition from influential special-interest groups, the announced rates cover wind, solar, hydro, and biomass projects. Of import to the marketplace is that the rates announced are lower than those that were recommended by the National Renewable Energy Board. The lower-than-expected rates are meant to soften the impact of the incentive system on electricity rates, while attracting investments in the renewables sector.
Bevash relates that: “Renewable energy is our hottest market and the Philippines are blessed with abundant resources. This is just another positive step the government is taking to normalise the process for development and financing of new power projects to secure its own long-term needs for dependable and renewable energy.” According to a recent study by the World Wildlife Fund, the country has the potential to develop 1200MW of geothermal capacity, 2308MW of sustainable hydro, 235MW of biomass, and 7404MW of wind power capacity over the next 10 years.
Smith posits that: “The Philippines doesn’t have much in the way of possible fuel resources. But it does have a lot of sunshine, good wind, and excellent geothermal reserves. In terms of biomass as well, a lot of the agricultural practices work very well with those projects, such as the sugar cane industry. So renewable energy makes sense.”
Hydro projects have proven to be capital intensive. However once set up, they are lucrative. “Investors in the hydro space have a great track record in the Philippines, however in terms of its use in the power mix, droughts and issues with capacity storage periodically cause challenges in regions such as Mindanao where there is a large exposure to hydro capacity,” reports Plenderleith, continuing that, “It is pleasing to see that long-term investors in the Philippines such as Marubeni Corp, of Japan, are continuing to invest in the domestic energy and infrastructure market. International and domestic investors, mostly those with existing power assets in the country, continue to explore opportunities”.
Taking a quick glance at solar and wind illustrates similar trends. Bevash points out that, “solar will become increasingly profitable and attractive as the solar intake panels come down in price, so these projects are definitely on a curve that is increasing in popularity because of the dramatically lower capital expenditures associated with these projects.” Wind is also a progressively popular form of energy production, as it is complementary to other forms of electricity generation. “If the wind is blowing in the middle of the day when electricity demand is highest, then wind is a very attractive peaking source of power,” continues Bevash.
However, now that the tariffs have been released, lawyers have cautious views as to how these will affect the market. “These tariffs alone do not solve the regulatory framework for renewable energy,” asserts Angel Salita, partner at SyCipLaw, “and there are still obstacles that need to be faced. For example, how do you allocate the 760 megawatts that have been set aside for renewable energy?
How do you implement and collect these tariffs from a developer’s standpoint?” He continues that while the approval of the feed-in tariffs is a major step in jumpstarting the sector, the fact is that the devil will be in the detail, and investors are warily waiting for those specifics.
Pacheco continues that: “A year ago, we had a lot of interest in renewable energy; we were doing work especially in wind and hydro projects. Then when the issue of the feed-in tariffs arose, there was a lull in the projects. Most were put on hold pending the outcome of the rates. And now that they are out, companies are evaluating to see whether or not they would be commercial in terms of the rates approved. So they are still in a holding pattern, and hopefully, we will see something in the next few months.”
What cannot be underestimated, however, is the tide of public opinion. Feed-in tariffs and renewable energy are sticky subjects, as Pacheco points out: “It’s a multifaceted issue; it is laudable what the government is trying to do and renewables are really the future. But from a consumer perspective, they would think ‘why should I pay more for this if traditional sources of fuel would mean the same or less electricity cost for me, while here I am subsidising renewable energy’. So the regulator, the ERC, is trying to balance the situation between consumers and the possible impact on businesses.”
Various sources point out that some investors have not wholeheartedly jumped on the bandwagon because they are hesitant as to how committed the government and the population will stay to feed-in tariffs over the next 10 to 15 years. “It’s naturally a hotly debated issue in the Philippines, about whether this is the right policy at the right time. Should the country be focusing its financial resources and legislative time on this renewables program while consumers face issues with power outages and high pricing compared with other competing economies in Asia. Not surprisingly, it’s a politically sensitive
issue,” reveals Plenderleith.
Lawyers agree that at the moment, from a developer standpoint, anyone who wants to avail of the feed-in tariffs should be in the process of developing their projects already. The outstanding issue is that of financing, and interviewees indicate that lenders are not willing to lend unless the finalised implementation rules and regulations for the tariffs are released. Optimistically, this would happen later this year or early in 2013. Until then, it is a waiting game.
A STEAMY SITUATION
Although not covered by the feed-in tariffs, geothermal energy is an undeniably steamy topic when it comes to renewables. The Philippines is a top world producer of geothermal power, second only to the United States. The country’s Department of Energy estimates that there is still about 4.41 GW of untapped potential for geothermal energy while currently, the Philippines has more than 2 GW of installed capacity, comprising nearly 18 percent of the country’s total energy output, according to a Baker & McKenzie report.
“Currently, geothermal power producers are upgrading their facilities, some have concessions on certain steam fields and are actively exploring and developing those concessions,” says Openshaw. Although the areas that contain steam reserves are limited geographically, many interviewees confirm that industry participants are keenly developing and expanding their projects.
However, there are some obstacles remaining in the renewables sector. Lawyers primarily identify an equity requirement by the government which states that only Philippine nationals (i.e. Filipino citizens or corporations, at least 60 percent of whose capital is owned by Filipinos) may harness renewable resources. “Foreign investors would normally want control of a project. However, under the constitution, renewable energy projects that harness forces of nature like wind and solar would be subject to this foreign equity limitation” says Quintero. Yet, geothermal developments are exempt from this rule and are allowed to be owned entirely by foreign investors, as the government has classified steam as a mineral, and not a force of nature. Meanwhile, sources mention that moves are underway in Congress to re- evaluate this position, as opinion is mixed as to whether steam has correctly been classified as a mineral resource.
At the moment, the marketplace is seeing “definite interest in greenfield renewables although the feed-in-tariffs are perhaps much leaner than some potential investors had hoped, “ explains Plenderleith, “there is also interest in further investment centred on existing power assets, for example, rehabilitating certain plants, improving their efficiency and thereby changing their economics. There is also interest in the expansions of facilities; investors are attracted to linking their investments to existing assets due to the potential for practical and commercial synergies and the relative simplicity of expanding a project that already has a patchwork of approvals, rather than starting something in a new locality.”
PHILIPPINES LIGHTS IT UP
The energy industry in the country is irrefutably a complex marketplace with myriad developments happening simultaneously. In general, however, offshore oil and gas, mining, and renewables have emerged as a success story for 2012; somewhat under-the-radar compared to the markets in neighbouring countries, yet undeniably a positive development.
When it comes to promoting foreign investment and moving the economy forward, “It’s very important that the government has the political will to undertake the appropriate, though sometimes, tough measures, and this administration has demonstrated that it does,” says Openshaw encouragingly, “We represent both the government and the private sector, and it’s not always that you find the two sides generally working at the same pace or in the same direction as they seem to do now.”
Bevash sums it up by saying: “The Philippines is a large nation with an educated, technically-proficient population and a young, vibrant economy that is poised for continued growth. It’s showing very positive trends for long-term expansion and advances in electricity, natural resources and any other building blocks for a modern society.”
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